Green Bond Boom Brings Growing Pains

[dropcap]A[/dropcap] €600m bond sold by a Scottish utility would not normally set pulses racing for anyone but the most committed followers of London’s debt market.

Yet, just such a fundraising by SSE plc last month attracted attention as a sign of growing momentum behind so-called green finance. SSE’s was the largest bond so far issued by a UK company with an official “green” label attached, adding to the global growth in financing ringfenced for projects which benefit the environment.

Less than a decade old, the green bond market raised $95bn last year and is on track to reach issuance of $123bn this year, according to Bloomberg New Energy Finance.

That remains a tiny fraction of the overall debt market but its expansion is forcing mainstream investors and issuers to take notice.

“More and more fund managers are diversifying their investment criteria to include green factors,” says Gregor Alexander, SSE finance director. “Not every bond will be green, but it will become part of our menu of options.”

To qualify for the green label, all bond proceeds must be committed to environmentally friendly projects, such as renewable power, energy efficient buildings and low-carbon transport. SSE, for example, is using its bond to refinance existing onshore wind farms.

European utilities Iberdrola, EDF and Engie are among others to have entered the market and France in January became the largest sovereign issuer, raising €7bn.

Green bonds have become one of the main outlets for a growing pool of international capital which comes with environmental or ethical strings attached.

Japan’s Government Pension Investment Fund, for example, has a target to move 10 per cent of its $1.3tn of assets into investments meeting certain environmental, social and governance (ESG) standards.

An estimated $10.4tn of assets worldwide involve some form of ESG measurement, according to the Global Sustainable Investment Alliance, an increase of 38 per cent from 2014.

Often dismissed in the past as a woolly concept driven more by public relations than returns for investors, sustainable finance is being forced into the mainstream by two forces.

The first is political and regulatory pressure related to global action against climate change. France in 2015 became the first country to introduce mandatory environmental reporting for financial institutions, compelling fund managers to disclose how they consider green performance when making investment decisions.

“Any institution or company that wants exposure to France now has to think about this and that is making a big impact globally,” says Zoe Knight, head of HSBC’s Centre for Sustainable Finance.

The second and arguably most powerful catalyst is the growing financial appeal of green investment as clean technology, such as wind and solar power, matures.

The World Bank’s International Finance Corporation has estimated that $23tn of investment will be needed between 2016 and 2030 to deliver the cuts in carbon emissions envisaged under the Paris climate agreement.

There are clear signs of this capital beginning to materialise, whether in the accelerating shift by companies such as SSE from coal-fired power generation to renewables, or rising investment by car companies in electric vehicles.

Green bonds look poised to play an important role in financing the transition but the market is not without problems. There is no agreed global standard for what qualifies as a “green” project, nor for the disclosures required of issuers to measure environmental performance.

This has led to controversy over whether traditional energy companies should be allowed to claim green credentials for bonds aimed at reducing emissions rather than eliminating them altogether.

Repsol of Spain became the first oil and gas company to issue a green bond in May, raising €500m to make its refineries and other infrastructure more efficient.

The bond was backed by research from Vigeo Eiris, the Paris-based environmental ratings company, showing that Repsol’s investments would avoid 1.9m tonnes of annual greenhouse gas emissions — equivalent to taking 400,000 cars off the road.

However, the bond was excluded from most of the indices which track green debt.

Nicholas Pfaff, senior director of market practice and regulatory policy at the International Capital Markets Association, says there will be different “shades of green” as the market evolves. It will be up to investors to decide how pure they want their green portfolios to be.

Demand for green bonds has so far outstripped supply, allowing issuers to price them at a premium. SSE’s eight-year green bond was almost three-times oversubscribed, resulting in the company’s lowest ever coupon for a senior bond at 0.875 per cent.

Liquidity is gradually increasing, with Chinese issuers prominent, but the market remains mainly buy-to-hold. “The biggest risk is tokenism,” says Mr Pfaff. “It is very important that issuers understand that they are signalling the transition of their business models. It should not just be a one-off.”